Ex Africa semper aliquid nova The introduction of a new national operator in South Africa

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1 Ex Africa semper aliquid nova The introduction of a new national operator in South Africa Dr Angus Hay, Chief Technology Officer, Transtel Transtel Transtel is the telecommunications division of Transnet Ltd. Transtel has been positioning itself to take its place in the public telecoms market since it was created in It is currently one of the largest full-service private telecommunications operators in the Southern Hemisphere, and recognised as an operator by the International Telecommunications Union. Although a fraction of the size of the incumbent public operator, it is nevertheless a real telco, with all the trimmings customers services, technical expertise, support services and a countrywide presence quite apart from an extensive network with existing rights-of-way, equipment buildings, high sites, depots, an international satellite teleport, and major corporate customers. Transtel has substantial experience in network deployment, including a major portion of the MTN network, as well as installations for the national lottery and others. It operates a national transmission, voice, data, mobile radio, and satellite networks. Unlike Telkom, Transtel has operated in a competitive environment for several years, since its Transnet customers have a choice of service providers. Transtel has supplied sophisticated services to a group of demanding customers, at prices that are repeatedly compared with those of Telkom. Moreover, many of the services provided are mission-critical, and subject to stringent service level agreements. Transtel has a presence in 17 African countries outside of South Africa, offering primarily VSAT and related services. Eskom Telecommunications Telecommunications is one of the core business activities of Eskom Enterprises (Eskom s subsidiary housing its businesses not regulated by the National Electricity Regulator). Eskom Enterprises secured and holds a significant equity stake in Tele-Com Lesotho, and is pursuing ventures elsewhere in Africa. A division of Eskom Enterprises operates the Eskom Private Telecommunications Network, providing mission critical communications to the Eskom Group. The Eskom PTN is a modern and robust telecommunications network, consisting of: Fibre optic and microwave transmission systems Countrywide mobile radio systems A largely digital voice network X.25 and frame relay data networks The current environment We live in uncertain times. There is uncertainty in the world economy; there is a great deal of uncertainty in the telecommunications industry. In South Africa, there is uncertainty about the Telkom Initial Public Offering (IPO) of shares, and there is uncertainty about the licence for the Second National Operator. Neither the Telkom IPO, nor the SNO licence is in any doubt, of course, but the order in which they will occur is still not clear. It is quite possible that those planning to invest in Telkom shares will not even know who the competition will be by the time of the listing. That's not quite true, of course. They'll know, for example, that Transtel and Eskom Telecommunications will be involved. So far, although the two state enterprises are the only confirmed participants in the licence, they together provide a very substantial base upon which to build the new national operator. In this paper, I ll explore the future of the telecommunications market, and the fixed market in particular, and look at the opportunities for the new national operator.

2 Fixed vs mobile It seems so simple to divide telecommunications operators into two categories fixed and mobile. In South Africa, this is all we've ever known. The reality of the telecommunications business is much more complex. In fact, the simplest way to look at the market is a) mobile and b) the rest. In the rest of the market, analysts talk about tier one carriers (the few large, typically incumbent global players), tier two carriers, alternative carriers, long distance carriers, local exchange carriers (incumbent or competitive or data ILECs of CLECs or DLECs), and international carriers of carriers. Even cable TV companies are in telecoms today. In South Africa (and in India and China), we have a new category, fixed-mobile. I'll say more about this later. It is easy to forget that the bulk of telecommunications is fixed, including the high-speed fibre backbone networks, the fixed voice networks, the various leased line and switched data networks, and, of course, very nearly the whole of the Internet. In this country, the dominance of fixed networks is even more complete, since the mobile operators are required to use fixed operators to provide all of the links connecting their sites and switching centres, and for all of their international traffic. For the foreseeable future, the South African fixed market will not have any of the subtleties of other markets, and will be dominated by two operators Telkom and the SNO. (There will be some other players, in the form of Sentech and the Under-serviced Area licensees, but they represent specific niches, which I shall touch on later.) The mobile phenomenon of the last few years should not be compared to other telecoms growth. The explosive growth of mobile communications in the last few years is best compared to almost every other consumer innovation of the twentieth century from vacuum cleaners to television. After a few years of slow growth, the market explodes, as the product moves from being an expensive novelty to being an essential tool of modern life. The growth rates seem extraordinary, and, of course, they are, because such markets eventually reach saturation. Once everyone who can afford a TV has one, the growth of TV sales becomes ordinary. It is important to understand this in the context of the broader telecommunications market, which is much more mature, and experiences slower, but steady, long term growth. Nevertheless, for some services, like consumer telephony, the major competitors for fixed operators are no longer other fixed operators, but mobile operators. Despite high numbers of users, mobile traffic accounts for no more than a fraction of a percent of total telecommunications traffic. Conversely, only a fraction of a percent of Internet traffic is carried over mobile networks. Projections for 3G mobile networks have been substantially revised. Unless there is real demand for the mobility, the dominant broadband networks will be fixed for the time being. Fixed trends Mobile growth is but one of several trends in the broader telecommunications market. But let's not forget the others. Globally, the demand for bandwidth has been driven primarily by one even more spectacular phenomenon the Internet. Fortunately, technology has been able to keep up with the bandwidth demand, and it seems unlikely that core networks will be unable to cope, at least in most developed countries. The same cannot be said for access networks which consist mainly of millions of kilometres of copper, are often quite old, were not originally built to support broadband services. For incumbents, this is a two-edged sword. More about this later. The introduction of competition in many developed markets has resulted in a glut of bandwidth, and rapid reduction in the price of bandwidth. In this regard, South Africa has been left behind, and we now represent a relatively narrowband island in a broadband ocean. For the first time last year, the country slipped into second place on the African continent, in terms of international Internet bandwidth (according to BMI-Tech). South Africa represents 54% of the continent s Internet subscribers, but only 26% of the international bandwidth. Some of the other market trends are not so obvious: Broadband access (for smaller businesses and consumers) is finally bringing about the paradigm shift that fixed operators have so long sought from separate, low bandwidth services, to multiple, simultaneous, combined voice and data services. In many cases, this just means Internet access, but there's a lot one can do just with broadband Internet access, if the price is right. Broadband access, although it has been slow to take off globally, is now fairly well-established except in South Africa, where broadband access is has come as too little, too late. The most successful broadband operators around the world have taken a mass-market approach, making the service available and affordable to a large percentage of their users. (Broadband access is less of an issue for large corporate main offices, which typically already have high bandwidth links, but their need for bandwidth is just as critical.)

3 The boundaries between fixed operators, mobile operators and Internet providers are blurring. Increasingly, we talk of access providers, who may be fixed or mobile (or both), and service, application, or content providers, who may offer these across multiple platforms. This principle can best be seen in the nature of licensing, where there is difference between facilities-based and service-based licences. Many incumbent operators aim to be both facilities and service providers. Data continues to grow faster than voice. According to Gartner, data revenues will grow from a quarter to a third of total fixed revenues by Voice over IP will grow from 1% of revenues to 6% in the same period, an interesting prediction given South African regulations. There is substantial growth in some fixed services. As an example, it is expected that the managed network services market in the US will grow tenfold in the next decade. There is also a strong trend towards non-realtime communications such as voice mail and . For both fixed and mobile operators, such services are now regarded as standard, and are often offered as part of a standard package. For many users, of course, non-realtime services are Internet -based. Increasingly, operators bundle services. This is not merely a consequence of the new network technology that makes this possible, but also a tool to maximise revenue and minimise churn. With the introduction of new services, there will also be substantial growth in fixed ARPU (Average Revenue Per User). In terms of physical network access, there are some interesting trends: There is a small but growing trend towards the use of wireless access (from the traditional wireless local loop at the low end, to broadband wireless access at the high end). Wireless access is finally coming into its own, and not only in developing countries. It can now offer a realistic alternative to broadband wireline technologies such as xdsl. Compound annual growth rates of up 30% are predicted for this market over the next few years. More and more individuals are using the same devices (cell phones, notebook computers etc.) for both business and personal communications. Although this may seem to offer opportunities for mobile operators, a number of major fixed operators are already planning to take advantage of this, offering wireless hotspots, and promoting the connected home. The South African regulatory environment: "Plus ça change " As a result of the Telecommunications Amendment Act in November last year, the legal framework has been established for the introduction of competition in the South African fixed telecommunications market. Although the law provides the basis, there is much more that defines the total regulatory environment. Although there has been a tremendous amount of regulatory activity in the past couple of years, the regulatory environment remains essentially as it was defined in the 1996 Telecommunications Act. South Africa continues on a path of phased liberalisation, with the introduction of a Second National Operator as the incumbent s monopoly expires, exactly as stated in the 1996 Act. To a large extent, the Amendment Act merely adds clarity to this process. At face value, the environment is good for the SNO, provided that ICASA shows its teeth, as it is starting to do. Basic regulations on facilities leasing, interconnection 1, numbering plan, and carrier pre-selection are good by global standards. Number portability 2 will not be possible before Interconnection refers to the physical and logical linking of the facilities of commercial organisations providing telecommunications networks and/or telecommunications services, in order to allow customers connected to different networks to communicate, to ensure the interoperability of services, and to increase the choice available to customers. (ITU Definition, 2000) 2 Number portability refers to the ability of users of telecommunications services to retain, at the same location, existing telecommunications numbers without impairment of quality, reliability, or convenience, when switching from one telecommunications carrier to another. Geographic number portability allows users to keep their number when they move from one geographic location to another. Non-geographical portability allows users to keep their number when they move from one fixed-line service provider to another. Mobile portability allows customers to retain their number when they move from one cellular service provider to another.

4 Far more importantly, the Competition Commission and Competition Tribunal will have jurisdiction over telecommunications, ensuring fair competition, as is seen in other countries (a good example is Australia). There is still work to be done on the regulatory front, but the playing field is now sufficiently level to allow for the introduction of a new operator. The environment will be further improved if the regulator succeeds in introducing shared access 3 to the local loop (a step towards local loop unbundling 4 ), as recently gazetted, and meets the deadline of the end of 2003 for the introduction of carrier pre-selection 5. There are some remaining issues, particularly around access to spectrum and the associated costs, but these are not fundamental limitations. Fair access to international undersea optical fibre systems is also still a contentious issue. Telkom should not be too worried. Competition typically has a dramatic, positive effect on previous monopoly operators. British Telecom s experience was that they had to involve their customers more, improve the quality of their service, and make dramatic internal changes, including reducing staff, changing staff, and paying staff more. Yet they experienced competition in every aspect of their business, and, of course, their competitors were some of their biggest customers. The SNO opportunity So why are Transnet and Eskom bullish about the SNO investment? Taking some basic World Trade Organisation regulatory guidelines as a benchmark, South Africa is not far off the mark. The new national operator will not have severe Universal Service Obligations 6 (USOs) as Telkom had. Overall, the commercial environment is fair, and will improve as further deregulation occurs. When looking the prospects for the South African telecoms market in the next few years, it s all a question of perspective. Analysts are quick to point out that total fixed telecoms revenue is unlikely to increase much, since, when weighted for population and GDP, it is already high by global standards. What they don t mention is that tariffs in South Africa are also still high, and that, as competition is introduced, users will get more and better services and lower prices. For the consumer, this is surely good news. Network operators will have to improve efficiency and reduce costs to achieve the same profitability and keep their shareholders happy. Transnet and Eskom have analysed the opportunity extensively, and have jointly developed a business plan for an efficient, yet profitable new national operator. Both have backed this with substantial investment in new network infrastructure to support the new operator. As future shareholders in the SNO, Transnet and Eskom are confident of building a strong operator, and gaining a reasonable share of the market. 3 Shared Access is the leasing of a portion of the local loop or sub loop, generally the higher frequency spectrum of the local loop, to provide services such as high-speed data and Internet services while the facilities provider continues to use the same local loop or sub loop to provide services to its customers. (ICASA Definition, 2002) 4 Unbundling the local loop is the provision of access to the local loop (last mile of the network) of the incumbent operator to new entrants for a fee. Advanced unbundling schemes enable competitors to actually lease an access circuit to a particular customer across the incumbent's network on a cost basis. Another version enables unbundling at the socalled physical level, where the competitor leases the actual copper wire from the incumbent to the home or business, and provides the supporting electronics at both ends. (ITU Definition, 2000) 5 Carrier pre-selection allows the choice of an alternative operator as the default service provider. The user nominates a carrier in advance and the access network operator (usually the incumbent) automatically forwards calls to the right operator (ITU Definition, 2000). Carrier selection permits the choice of an alternative telecommunications service provider on a call-by-call basis. This is achieved via the use of a prefix code causing the call to be forwarded to the carrier of choice. (ITU Definition, 2000) 6 Universal Service is the provision of telecommunications services permitting access to a defined minimum service of specified quality to all users everywhere, and at an affordable price. The notion of Universal Service also includes service to disadvantaged users. Universal Service Obligation is defined as the obligation placed upon one or more operators to provide Universal Service. (ITU Definition, 2000)

5 Transtel and Eskom Telecommunications It is important to recognise that the Transnet and Eskom shareholdings are not set asides in the true sense. Both state enterprises are active investors in the telecommunications market, and see the new national operator as a business opportunity. The contributions of the two enterprises will match their proposed 30% equity stake in the SNO. The investment is more than just cash, and includes a number of unique contributions, such as the joint network being deployed, and substantial rights-of-way. Already, the SNO licence has stimulated the telecommunications supply industry in South Africa, through the two state-owned enterprises, with current infrastructure build totalling R2 billion. Once a competitive market is in place, this industry will be further stimulated. Transtel and Eskom Telecommunications bring value; both are committed, long term investors, and have analysed the opportunity extensively. Jointly, the two state enterprises are working together to ensure a successful new operator, and that the national network will be ready to deliver. Eskom Telecommunications and Transtel bring local and African operating experience, dependability and Transtelligence. Sentech and Under-serviced Area Licences There is still some concern over Sentech s new licences multimedia and international carrier of carriers. Terrestrially, Sentech is likely to be client of the SNO. It may be a competitor in some areas, and a partner in others. The challenges are clear: The international carrier is a very tough market, there is no clear precedent for a multimedia licence, and there will be no strategic equity partner for Sentech in the near future. It is expected that Sentech would become fully operational simultaneously with the SNO. The proposed Under-serviced Area Licences represent an innovative approach to increasing teledensity in Underserviced Areas (<5%). They aim to achieve empowerment of communities and SMMEs in the identified areas (initially 10 areas), and use competition as the tool to grow the market. Nevertheless, the business model will be very challenging, making this a less than ideal empowerment opportunity. The success of these businesses will depend on partnerships. Fixed, mobile and fixed-mobile Convergence is a buzz-word, which most people don t really understand when they use it. There is true convergence of voice and data networks such as the network being built currently by Transtel and Eskom Telecommunications but mobile networks remain physically separate from fixed networks, for the moment. Fixed and mobile networks will truly converge in time, but not in the near future. Fixed-mobile is a concept initially borrowed from India, where fixed operators using mobile frequencies for wireless local loop found that the users simply unscrewed the terminals from the wall and carried them around. This is a consequence of using a mobile wireless technology. China has also successfully implemented fixed-mobile. In India, limited mobility is allowed in an entire town, for example. Here, it is essentially limited to one cell. That makes the business case challenging, but it does provide the only viable alternative to fixed lines for the low end of the market. It can be pre-paid, and hands off for the operator, with no involvement in the CPE. Customers will probably use normal handheld terminals. In the short term, it is likely that a new fixed operator will, in any case, seek a commercial alliance with a mobile operator. With regard to the regulation of fixed-mobile, one issue remains of concern. Although any appropriate mobile frequency band, and any mobile technology can be used, the pricing of spectrum will determine the choice of technology. Fortunately, a number of alternatives technologies, including both GSM and CDMA, could be used. The multi-service operator and the Next Generation Network The new national operator will be a broadly-based telecommunications operator, offering a similar range of services to the incumbent. The key concepts are multi-service, and the Next Generation Network: Services are delivered to customers through a single, multi-service pipe, as broadband as the user requires. The connection will typically support voice, data and Internet (or any combination).

6 By deploying broadband, packet-based infrastructure based on the next generation network concept, a new operator can minimise the capital investment required, whilst maximising the potential for converged voice and data services, value-added services and revenue. Broadband vs narrowband access Everyone is talking about broadband, with the recent launch of Telkom s ADSL (Lite). In general, though, there is not one kind of access technology, especially in the case of a Next Generation, multi-service network. Obviously, narrowband access will continue to dominate for the next few years. So why is broadband access important? Isn t this just another 3G? Just as there is a correlation between teledensity (telephones per head of population) and GDP per capita, Gartner has established a similar correlation between broadband access and GDP per capita. This is particularly true in developed countries, but it does have some implications for developing countries. Increasingly, the digital divide will not be between those countries or regions that have telephones and those that don t but between those that have broadband (particularly Internet) access, and those that don t. Already, some forecasters predict over 100 million broadband users worldwide within a couple of years, with almost none of these in Africa (In-Stat/MDR predicts 46 million users by the end of 2003, and emarketer 117 million by the end of 2004). There is talk of a broadband Europe, or a broadband US, but not of a broadband Africa. Transtel and Eskom Telecommunications network Transtel and Eskom Telecoms new joint network spans the country, linking all of the major centres, and providing high bandwidth Metropolitan Area Networks (MANs) in the metros, and delivering all of the services that the new national operator will need. Success of the SNO It is difficult to predict the market share for the new operator in South Africa, where there has been no history of competition. However, estimates can be made based on international benchmarks. Individual operator market share is very dependent on the strength of the new operator s value proposition, and the ability of the incumbent to defend itself. In some markets, uncompetitive incumbents have lost large percentages of their market share in the first few years, but the average (for environments similar to that in South Africa) is 15-20% over 10 years. Our experience of the South African telecoms market is that users are far more fickle than their counterparts elsewhere in the world, as well as being far more price-sensitive. This is borne out in recent market research done by BMI-Tech, as well as in churn experienced when Cell C entered the mobile market. In South Africa, the corporate sector is typically equal to its counterparts in the developed world, and it has similar expectations in telecommunications services. The small to medium business and high end of the residential sectors can also be compared quite favourably to many developed countries, although somewhat price sensitive. In metropolitan areas, there is a strong case for high bandwidth Metropolitan Area Networks, such as have been built in Western European and North American cities. South Africa has a very high GINI coefficient (spread of income levels from highest to lowest), and addressing the broader residential market will therefore be a challenge for the new operator. However, new technologies and innovative approaches will be the key to addressing this market. Conclusion Telkom s monopoly has been much broader than most realise, and certainly better protected than others around the world. Nearly every conceivable telecommunications service, from a cellular telephone call to Internet access, passes through a Telkom network at some point, and provides it with revenue. Herein lies the greatest opportunity for the new national operator. Overnight, the new operator will be allowed to compete with the incumbent in all its market segments. The new national operator licence represents a major opportunity in the South African telecommunications market for investors, for telecommunications re-sellers, and for the end users. The market is ripe for competition, and a choice of operators will be good for all stakeholders. The future is going to belong to the innovative and the fast, not to the big and the diversified.